In 2005, the Republicans were bragging that the economy was booming and we were in a bull market. They were later disappointed to see that the economy was not in a boom, rather a bubble. Republicans have (again) been all over the news lately proclaiming how the economy is booming, and we are in the longest bull market in history. I say with no doubt that Republicans and Trump supporters will soon be devastated when they realize that the current economic situation we are facing is not much different from the situation we faced a few years ago.
To understand why, it is important to understand the fed–which is talked about in my previous article called Fiat Money and Central Banking: The Fall of Any Good Country–, and the effects of artificially lowering interest rates. Many Keynesians and monetarists believe that the boom-bust cycle is a natural byproduct of the free market and that the federal reserve must fix it by stimulating the economy back to expansion. This is a dangerous misconception. The federal reserve is the reason that we have the boom-bust cycle in the first place.
When people save money, there is more money for the banks to loan out, therefore lowering interest rates. Low-interest rates send a signal to the factors of production that there is more money for the banks to finance their capital investments for long-term productive purposes. When the federal reserve artificially lowers interest rates, it sends a false signal and the market mistakenly allocates capital as if savings had increased, even though it hadn’t. This leads to what Ludwig von Mises calls “malinvestments.”
The “economic boom” (like what we are facing right now, and faced in 2008) is where all of this malinvestment happens. Ultimately, the bust occurs when the market tries to liquidate these malinvestments and put the factors of production back into a more sustainable allocation.
What I just explained is called the Austrian Business Cycle Theory. While commonly discredited as false by Keynesians, it couldn’t be any truer, with historical evidence on its side.
When the dot-com bubble collapsed in 2001, Alan Greenspan and the federal reserve set interest rates to 1%, giving us the real estate bubble. Investors claimed the housing market was rigid and the economy was booming. In September of 2007, many opinions began to turn sour when Lehman Brothers filed bankruptcy. The outcome of the recession was eight million Americans losing their jobs and six million losing their homes. The economic crisis was one of the worst recessions in U.S. history.
The federal reserve responded to this recession by beginning multiple rounds of quantitative easing (How Does Quantitative Easing Affect the Stock Market?) and setting interest rates to zero for multiple years. This put the housing and stock market back into a bubble, this time making it much worse, due to the interest rates being pushed down further, and longer than before. Trump even said during the first U.S. Presidential Debate: “We have the worst revival of an economy since the Great Depression, and, believe me, we’re in a bubble right now. The only thing that looks good is the stock market, but if you raise interest rates even a little bit that’s going to come crashing down. We are in a big, fat, ugly bubble, and we better be awfully careful. We have a fed that’s doing political things by keeping the interest rates at this level, and believe me, the day Obama goes off, when they raise interest rates, you’re going to see some very bad things happen.” While Trump was wrong about the fed raising interest rates once Obama leaves, he was right about one thing. We are in a bubble, and it’s only a matter of time until it pops.
In June 2006 the S&P/Case-Shiller U.S. National Home Price Index read 184.61500, yet just this past August, the housing market hit pre-recession rates reading 205.80600. Since the Great Recession bear market bottom in March 2009, the bellwether S&P 500 stock index is up 300%. The index is 80 percent higher than it’s 2007 peak. The Russell 2000 small-cap index is up 400 percent and the tech-centric Nasdaq Composite Index is up 500 percent. Evidence shows that there not only is a bubble but that it’s also crashing soon.
Housing inventories are going up, homebuilder stocks are collapsing and the housing data hasn’t been this weak since 2008. What we are seeing right now is very reminiscent of 2007 and 2008 when the bottom dropped out of the economy. The stock market has been slipping, with the DOW and other stocks taking many hits over the month of October and a little bit of November so far.
When the fed set interest rates much lower in response to the 2008 financial crisis than they had in response to the dot-com bust, they created the bubble that our economy is currently wrapped in and made it much worse than the one before it. It is only a matter of time before the stock market and housing market crash again, this time being much worse than that of 2008. It is highly likely that in response to this crash, the federal reserve will lower interest rates even further than they had before, and for even longer. It is only a matter of time until this cycle of creating bubbles in an attempt to fix economic recessions comes to an end, with hyperinflation being the end result.